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Tuesday, April 23, 2013

Bubble Bursting?

I have written several times in the past about gold, like here and here. I am not a fan of gold as an investment or an advocate of the gold standard, although I admit that it does make pretty jewelry.Back in 2004, the price of gold went on a huge run, rising from about $400/oz to almost $1,900 per ounce last October. That's almost a 500% increase. However, we also have to remember that if you bought gold in 1980, at $800/oz, it took until 2008 for you to recover the $800. That's almost 30 years of 0% return, which means that, from an inflation adjusted perspective, that ounce of gold in 1980 lost more than half of it's purchasing power. In fact, at $1,900/oz last October, gold had finally made it almost even with inflation since 1980. This price history, short-term jumps, and long-term difficulties, looks exactly like a speculative investment, not a good long-term choice.Recently, we have seen the price of gold drop precipitously, from about $1,600/oz at the beginning of April to $1,360/oz on April 13th. That's a 15% drop in two weeks and almost a 30% decline since last October. Here's a chart of two year gold prices:

I have no idea if this is the beginning of a steeper decline in gold prices or a temporary setback in a longer-term rise on gold prices. What I do know is that the price of gold is almost entirely determined by speculation, not any form of intrinsic value or future cash flows. Speculative markets are dangerous and should be avoided by long-term investors.Finally, here is a link to a blog post from the New York Times which discusses the recent drop in gold prices as reversion to the mean. I really like the last paragraph so I've excerpted it below:

"I was going to close this post by making fun of a just-published book, “$10,000 Gold: Why Gold’s Inevitable Rise Is the Investor’s Safe Haven” and suggest putting it on the same shelf with “Dow 36,000,” published in 1999, or “Are You Missing the Real Estate Boom? The Boom Will Not Bust and Why Property Values Will Continue to Climb Through the End of the Decade — And How to Profit From Them,” published in 2005. But then I noticed that the publisher of the gold $10,000 book also published “Gold Bubble: Profiting from Gold’s Impending Collapse” in April 2012, so I will let it pass."